Reporting Laws Turn Banks Into Government Agents

Banks are not only watching their customers more closely these days. They’re telling on them, too.

In an attempt to combat money laundering, a little-known federal law has turned U.S. banks into an army of secret government agents. Each year, banks are reporting tens of thousands of their customers as suspected criminals to law enforcement agencies. In most cases, customers never learn that their names and private financial information have been disclosed.

The goal of the filings--which are up 56% over the past two years--is to nab drug dealers, gun traffickers and corrupt politicians.

But in the government’s effort to catch criminals, critics worry that the system also is ensnaring innocent people, whose privacy is compromised because of mistakes or misunderstandings by banks. As a result, some customers may find themselves explaining their finances to the Internal Revenue Service, under government surveillance or, in extreme cases, facing the seizure of their bank accounts or imprisonment.

“It ruined me,” said Terry “Bo” Digby, who was handcuffed, arrested and thrown in jail after his Texas bank incorrectly fingered him for fraud. Digby, 44, had defaulted on a $100,000 loan, and he believes his bank reported him as a way to get even. Eventually he convinced a jury that the charges were bogus, and last year he collected $1 million from Texas Bank, which today is part of Wells Fargo. But the damage, he said, was already done.

“I became the biggest crook in town,” said Digby, who runs a trucking business in Odessa, Texas. His wife divorced him. He said he was embarrassed to go to the grocery store.

“People don’t realize what can happen when your bank turns you in,” he said.

Most people never find out. Banks are prohibited by law from telling customers they’ve filed a so-called suspicious activity report, or SAR. Digby found out only by accident, his attorney said.

Once reported, the information--which includes a customer’s name, address, occupation, Social Security number and basic account details--is forwarded to a special database run by the Financial Crimes Enforcement Network, or FinCEN, a government intelligence agency under the Treasury Department that is in charge of battling money laundering.

From there, the reports--expected to total 124,000 this year, including about 31,000 in California--are analyzed by law enforcement agencies nationwide, from the FBI to the IRS to local police departments. Foreign governments are also given access on request. No search warrant or court order is required.

Recently appointed FinCEN director James Sloan calls the reports one of the most effective anti-money-laundering tools at his disposal. “We are relying on the experience and instincts of the financial community,” he said.

But exactly how helpful they are remains unclear. FinCEN will not say how many reports result in investigations or convictions. While there have been no studies to determine how many innocent people are being reported, a 1998 FinCEN review estimated that as many as one in five reports are unrelated to a serious crime. In addition, about 45% of all reports involve amounts under $10,000, far below what most law enforcement agencies require to launch an investigation.

That has led some critics to worry that the reports are missing their intended target. Rather than uncovering global money-laundering schemes and drug rings, too many reports are being filed on small, ordinary bank customers, said Gregory Nojeim, legislative counsel for the American Civil Liberties Union.

“The vast majority of transactions involve people who are engaging in innocent activities,” Nojeim said. “They are never charged and many are never even investigated.”

Earlier this year, Rep. Ron Paul, a Texas Republican, sponsored legislation that would repeal the SAR program. Alternatively, Paul wants to give consumers the right to review their FinCEN files and correct mistakes, as they can for other types of government files kept on citizens.

Though helpful to law enforcement agencies, the reports represent one of the fastest-growing threats to the privacy of Americans, according to Paul.

“We’re teaching bankers to spy on people,” Paul said. “This just gives the government additional information about people that it shouldn’t have. It throws a blanket of suspicion over all people.”

Bankers ‘Deputized’ as Government Agents

Banks have long had a duty to report suspected criminal activity, and in 1985 “criminal referral forms” were created to make the process easier. But what began as an effort to improve communication and cooperation between banks and law enforcement has evolved into a strictly enforced mandate that forces banks not only to report suspected criminal activity but to actively hunt for it among their customers.

In 1996, FinCEN replaced the old criminal referral forms with SARs as part of a government crackdown on money laundering.

“All of you have been deputized,” Miami attorney Gary Bagliebter told a group of bankers at the American Bankers Assn.’s recent annual money-laundering conference. “You don’t carry a badge or what the FBI calls ‘creds,’ but I’m here to tell you, you should all consider yourselves to be agents of the government in the war on drugs.”

Helping FinCEN enforce the rule are bank regulators such as the Federal Deposit Insurance Corp. and the U.S. Comptroller of the Currency, which now review SAR filings as part of every institution’s regular audit for safety and soundness. If a bank isn’t filing as many reports as its peers, regulators may cite or criticize the institution, creating informal quotas for the filings.

As a further incentive for banks to monitor their customers, federal law permits the government to fine or file criminal charges against a bank for failing to file a SAR on the criminal activity of its customers. Banks are liable even if they were unaware of the criminal activity, as long as authorities can show that the bank “should have known” about it.

It’s little surprise, then, that filings are soaring. In 1996, banks filed about 50,000 reports in the program’s first nine months. This year, FinCEN is on track to collect about 124,000 reports.

In return for their help, banks have demanded--and received--the same immunity granted to law enforcement agencies to protect them against lawsuits from customers in case they make mistakes or incorrect filings. The Digby case was one of the few customer lawsuits to break through this so-called safe harbor protection.

The combination of secrecy, legal immunity and government pressure to file has created an environment in which banks have little to lose by reporting their customers.

“The system is set up to encourage filing,” said L. Richard Fischer, a leading financial privacy attorney at Morrison & Foerster in Washington. “So from the banker’s perspective: When in doubt, file.”

Deciding What Is Suspicious

What constitutes “suspicious” activity? Deciding which customers to turn in is often the toughest part of the job, bankers say. Though the government requires banks to report suspicious activities, it doesn’t precisely define what that means, leaving many bankers scratching their heads.

“It’s like the definition of pornography,” jokes one banker. “You’re supposed to know it when you see it.”

Some activities are easy calls: intentionally writing bad checks; wiring large amounts of money to offshore accounts or certain foreign countries; depositing bags of cash; or attempting to avoid government-mandated currency reporting rules by making several cash deposits just under the $10,000 limit, a practice known as “structuring.”

But the subjective nature of the regulation guarantees that activity considered suspicious at one bank may not raise red flags at another. To help sort out the confusion, regulators and industry experts have created a laundry list of “suspicious” activities that often prove perfectly innocent, critics say.

For example, Money Laundering Alert--a widely read industry newsletter written by former federal prosecutor Charles Intriago--suggests that suspicious customer behavior can include “unusual or excessively nervous demeanor,” reluctance to answer questions about finances, frequently depositing dirty or musty bills and opening a safe-deposit box but rarely visiting it.

On the other hand, excessive use of a safe deposit box is considered suspicious by the Office of the Comptroller of the Currency’s SAR handbook.

“It’s mush ball,” said Gordon Greenberg, an attorney at McDermott, Will & Emery in Los Angeles and coauthor of some of California’s money-laundering laws. “Under the rule, almost anything can qualify as suspicious.”

Banks stress that no single activity from these lists is usually enough to merit filing a SAR.

“We don’t do this lightly,” said Frank San Pedro, chief of security at Imperial Bank in Los Angeles. “Things may appear suspicious at first, but upon investigation they make perfect sense.”

Most banks say they carefully review the facts before filing a SAR, consider the customer’s history and discuss the case with top managers.

But banks admit that the task is made more difficult because bank tellers, typically the lowest-paid and least-experienced employees, are their first line of defense in spotting suspicious activity.

“Those are not exactly the skill sets we are looking for when we hire tellers,” said Stuart Lehr, chief compliance officer at Union Bank of California.

Almost everyone agrees that mistakes are inevitable.

A report earlier this year from the Treasury Department’s inspector general found that “the accuracy of the SAR data needs improvement.” The report suggested that low-wage FinCEN contractors had made data-inputting errors, including one example of a $5,000 transaction that was recorded as $5 million.

Rep. Paul’s office has also been collecting stories about banks that have mistakenly reported the wrong name or Social Security number.

Frequently, activities that look suspicious later turn out to be easily explainable.

For example, last year several Los Angeles banks serving Chinatown noticed a sudden surge in cash deposits by local merchants, all curiously just below the $10,000 threshold for filing a currency transaction report. Suspecting merchants were trying to launder cash, banks began filing SARs on the shopkeepers, according to Gene Elerding, a banking attorney at Manatt, Phelps & Phillips in Los Angeles.

Later, it was discovered that the merchants had all attended the same small-business seminar in which they were cautioned not to keep more than $10,000 cash at their shops. “So when the cash drawers got near $10,000, they went to the bank,” Elerding said.

Sometimes customers pay a stiff price for a bank’s misunderstanding.

In Florida, BankAtlantic became suspicious about some third-party checks moving from its offices in Miami to Colombia. The Fort Lauderdale-based bank reported the activity to law enforcement agents, who promptly seized 1,100 bank accounts--containing $22 million--that had some activity connected with Colombia. In the end, no criminal case was brought and a judge ruled the bank overreacted by turning over information about so many accounts.

But it was eight months before the customers--including many immigrants--got their money back, causing hardship for cash-strapped families and the collapse of some small businesses, according to Miami attorney Montgomery Blair Sibley, who is representing one customer in a suit against the bank.

Following the Money

Law enforcement officials say SARs have been helpful in cracking scores of money-laundering cases. FinCEN’s Sloan says banks have a duty and self-interest to cooperate.

“It provides an opportunity for financial institutions to keep illicit money out of their institutions,” said Sloan, who has proposed extending the reporting requirement to other types of financial companies, such as securities firms, casinos and check cashers.

Law enforcement task forces--consisting of representatives from the Justice Department, FBI, IRS, Drug Enforcement Administration, U.S. Customs Service and U.S. Postal Inspection Service--are gathering each month in a growing number of cities, including Los Angeles and San Diego, to review SARs filed in their regions, looking for possible leads or trends and cross-checking names against those of ongoing investigations. Some agencies receive daily downloads of SAR data.

“We follow money. That’s our job,” said Albert Allison, branch chief of the IRS criminal investigation division for Southern California. “And SARs are very helpful.”

Though reports are only supposed to be used for criminal investigations, the IRS is seeking approval to begin using them for civil tax audits, Allison said. In the meantime, IRS criminal investigators have found a way to refer cases to auditors by transferring the file but removing the confidential SAR form, Allison said.

To make the reports more accessible to law enforcement agencies, FinCEN plans to put the database on a secured Internet site soon.

Privacy groups worry about the database falling into the wrong hands, but Sloan said there is little harm to innocent people who are reported in the SAR database, even if they are investigated, because most often no one ever knows about it.

“There may be people [in the database] who are not guilty of anything,” Sloan said. “But SARs are confidential for that reason.”

Privacy advocates say consumers are hurt, regardless of whether they learn about the report.

“It’s like asking what’s the harm if law enforcement goes into your home while you’re not there, rifles through your personal financial papers, and you never know about it,” Nojeim said. “This is not a criminal investigative tool, it’s a massive surveillance system, built on the theory that the government has to watch every financial transaction in case someone does something wrong.”